How the North American Free Trade Agreement Works?

Subject: Politics & Government
Pages: 11
Words: 2752
Reading time:
10 min
Study level: College

Executive summary

This white paper entails an analysis of NAFTA, which is a well-established trading bloc in North America. The trading bloc is comprised of three countries, which include the US, Mexico, and Canada. The organization was established in 1994. The decision to establish NAFTA was informed by the need to eliminate trade barriers amongst the three countries in order to foster an enabling environment for business operations.

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Some of the core foundations of NAFTA include protecting investors, environmental protection, and fostering effective industrial relations amongst the three countries. In order to achieve this goal, NAFTA has established comprehensive accords that ensure that business operations align with the set rules and procedures. Since its inception, NAFTA has greatly improved the living standards of the member states’ citizens. This paper explores how NAFTA works.


The success of organizations is subject to the prevailing business environment. Some of the forces that influence businesses originate from the external environment. The economic environment is one of the key components that business leaders should take into account. However, the prevailing economic changes are beyond the business leaders’ ability to control. Despite this aspect, being conversant with the economic environment is fundamental in organizations’ strategic management processes. Possessing information on the business environment is a source of great intelligence that can be utilized in businesses’ decision-making processes.

Regional integration is one of the issues that countries are increasingly pursuing in an effort to promote their economic growth. Subsequently, numerous regional trade agreements have been established since the 1960s. Foxley asserts that these “ties are becoming more important as the global economic crises curtail demand from the major markets” (6).

The North American Free Trade Agreement [NAFTA] is one example of regional trade agreement. NAFTA was formed on 1 January 1994. Its member states include the United States, Mexico, and Canada. Mexican President Carlos Salinas, Canadian Prime Minister, Brian Mulroney, and the US President, George H.W Bush lea signed the agreement leading to the establishment of the North American trilateral trading bloc.

The organization’s administration centers are located in Washington, D.C. in the US, Ottawa in Canada, and Mexico City in Mexico. This white paper entails a comprehensive discussion on the various issues associated with NAFTA in order to provide insight on its role in enhancing the business environment.

Literature review

NAFTA provisos

Elimination of tariffs

The decision to establish this trading bloc was motivated by the need to “eliminate the prevailing investment and trade barriers amongst Mexico, Canada, and the US” (Foxley 69). Its formation led to liberalization of trade and investment amongst the member states. Prior to its establishment, over 9,000 import and export products between Mexico and the US were subject to trade tariff. However, by 1 January 1994, tariffs on 4,500 products were eliminated (Lederman, Maloney and Serven 71).

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Currently, NAFTA is considered as the largest trading bloc in the world. Upon its formation, trade tariffs on the US exports to Mexico were reduced by over 35%, while tariffs on Mexican exports to the US were reduced by over 50%. At its inception, the agreement sought to eliminate all trade tariffs between the US and Mexico within 10 years. On the other hand, trade between Canada and the US would be mainly duty free.

Stimulating investment

In addition to tariffs, NAFTA’s establishment also sought to promote innovation by implementing effective intellectual property rights and removing non-tariff trade barriers that hinder investment. One of the issues that NAFTA focuses on entails elimination of anticompetitive trade practices, which are mainly propagated by monopolies and cartels. Prior to the establishment of NAFTA, investors incurred substantial shipping costs, which increased their costs of operation.

In a bid to promote investment, NAFTA is committed to promoting an enabling environment for the operation of financial institutions. NAFTA has achieved this goal by implementing effective rules and guidelines for the operation of diverse financial institutions such as stock markets, insurance companies, and banks. The trade agreement has led to a significant improvement in the living standards of the member state’s citizens due to the imposition of effective investment coupled with trade rules and procedures.

NAFTA’s accords

In an effort to create an environment conducive for business, NAFTA has formulated other two main accords, which are discussed below.

North American Agreement on Labor Cooperation

NAFTA is cognizant of the view that labor issues can affect the business environment adversely. In order to deal with possible labor aspects, NAFTA has established an agreement on labor cooperation. This pact amongst the “US, Mexico, and Canada was established in January 1994 and the Commission for Labor Cooperation [CLC], which is comprised of a tri-national Secretariat and the Council of Ministers, undertakes the administration of the accord” (Seal 204). The council’s headquarters are located at Washington, DC. Currently, only a few provinces are signatories to NAALC. These provinces include Quebec, Prince Edwards Islands, Manitoba, and Alberta.

In the course of executing its duties, the Commission has an obligation to work in collaboration with the respective governments through the National Administrative Offices, which were established in each of the member states. The National Administrative Offices act as a contact point amongst the respective governments.

NAALC aims at fostering a good working environment for employees irrespective of their nationality. One of the ways through which this goal is achieved is by resolving trade and employment disputes. Therefore, the establishment of the NAALC has enabled the member states to cooperate in dealing with labor issues that might arise. Additionally, NAALC focuses at enforcing and protecting labor laws.

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NAFTA has adopted an effective dispute resolution mechanism. In the event of a dispute, the issue is referred to the secretariat for consultation. In extreme situations, an arbitration panel established by the member states handles dispute resolution. Upon successful completion of the dispute resolution process, the member state that has violated the NAFTA’s rules and regulations is penalized an amount that is decided by an arbitration panel (Hufbauer and Schott 75).

North American Agreement on Environmental Cooperation

Businesses are established with the objective of achieving profit maximization objective and surviving into the long term. However, achievement of this goal can be affected by environmental changes such as global warming and climate changes. In line with this aspect, NAFTA appreciates the role of environment in promoting long-term business operations. It is estimated that NAFTA is one of the most effective trading bloc with regard to environmental protection. Subsequently, the organization is extensively environmental sensitive.

In order to achieve this goal, NAFTA focuses at ensuring that businesses achieve environmental sustainability. In a bid to promote environmental sustainability amongst businesses, NAFTA formulated the North American Agreement on Environmental Cooperation [NAAEC] in 1994. NAAEC formed the Commission on Environmental Commission [CEC], which is charged with the responsibility of enhancing regional cooperation on environmental issues, to achieve operational efficiency. One of the aspects that CEC ensures is eliminating environmental conflicts amongst businesses within the member states (Chambers and Smith 88).

CEC ensures that businesses in the member states comply with the set environmental laws. Considering the high rate of global warming, which is stimulating climate change, CEC is committed to fostering effective environmental protection and conservation amongst businesses in North America. In a bid to promote sustainable agriculture, CEC ensures that the member states do not utilize harmful chemicals in their agricultural production such as DDT. Moreover, CEC has formulated a comprehensive environmental management system, which guides businesses on issues associated with conservation of natural ecosystems and wildlife. The commission is comprised of three main branches, with a total membership of 15 members as illustrated in the chart below.

Cooperation on Environmental Commission
Source: (Chambers and Smith 83)

The American, Mexican, and the Canadian governments fund the NAAEC. Its annual budget is estimated to be $ 9 million. The administration of the NAAEC is through consensus rather than the majority. Moreover, the public has the power to report any member state that is believed to be violating the set environmental laws. This aspect has significantly improved NAFTA’s effectiveness in protecting the environment.

Primary findings; NAFTA’s achievements

Economic prosperity

NAFTA’s establishment has led to a considerable improvement in the volume of trade amongst the three member states. For example, the volume of imports from the three member states has increased from $ 288 billion in 1993 to over $ 1 trillion in 2012, which depicts the region’s economic development and prosperity (Seal 92). The economy of the North American countries has doubled since the launch of NAFTA. The total Gross Domestic Product [GDP] of the three countries has since increased from $ 7.7 trillion in 1993 to $19.2 trillion in 2012 (Seal 92).

The formation of NAFTA has increased bilateral trade amongst the respective member states. For example, “trade between Canada and Mexico increased to $31 billion by the end of 2012; on the other hand, Canada’s export to the US grew with an annualized margin of 4.4% between 1993 and 2012” (Seal 121). In 2012, Canada exported over 75.7%of its products to Mexico and the US. Seal posits, “the establishment of effective trading environment has doubled the volume of trade between Canada and the US, while trade between Canada and Mexico has increased more than 7 fold between 1993 and 2012” (129).

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NAFTA has also led to a remarkable improvement in the volume of trade between Canada and the US. By the end of 2012, the volume of trade between the two countries was estimated to be $ 742 billion, which is approximately 41% of Canada’s GDP (Seal 95). The trade agreement has led to a considerable improvement in the US service export market. Canada is “the biggest consumer of the US service exports, which totaled $107.6 billion in 2012” (Seal 106). This aspect represents a 167.3% growth. On the other hand, the US provides a sizeable market for Canadian merchandise. Currently, the US imports most of its energy products from Canada and Mexico. Additionally, a significant proportion of foreign direct investments in the US are Canadian owned.

The establishment of NAFTA has improved the member states’ economic growth through the creation of employment and improved economic activity. Over 4.7 million jobs have been created in Canada since NAFTA’s inception. Consequently, the country’s unemployment rate decreased from 11.4% in 1993 to 7.2% by the end of 2012 (Seal 105).

NAFTA’s has stimulated economic growth in the US, Canada, and Mexico, which has led to the emergence of better paying jobs. For example, the hourly wage rate in sectors that support export bilateral trade between Canada and the two trade partners has increased with over 35% compared to non-export sectors.

Promoting investment

Foreign Direct Investment [FDI] has become a fundamental element in fostering cooperation between economies over the past decades. Furthermore, FDI is increasingly being considered as a critical element in promoting growth of domestic investments. One of the provisions in the NAFTA’s establishment is improvement in the investment environment by fostering a high level of economic stability and certainty.

Moreover, NAFTA is committed to ensuring that businesses operate in a transparent manner. This move has led to an improvement in the level of investment confidence amongst investors in the member states, which is a fundamental element in making long-term investment decisions and other partnership commitments (Baier and Bergstrand 5).

Therefore, NAFTA has greatly improved the level of Foreign Direct Investment [FDI], hence the flow of capital. It is estimated that the US received over $110.2 billion in foreign capital annually during the period ranging between 1994 and 2000. Conversely, the volume of FDI in Canada increased to $21.4 billion between 1994 and 2000. Therefore, the trade agreement led to the elimination of trade and non-trade barriers that previously hindered investment, which has enhanced investment opportunity within the three member states. For example, firms in Mexico can establish their operations in Canada effectively due to the set trade relations.

A report released by the Foreign Affairs Trade and Development Canada shows that Canadian investors have invested over $289 billion in Mexico and the US (Lederman, Maloney and Serven 101). Conversely, the size of FDI by Canadians to Mexico grew from $530 million to $5.6 billion between 1993 and 2012. By the end of 2012, the total bilateral investment between the US and Canada amounted to $616 billion. Therefore, NAFTA has greatly improved the investment relations between the member states.


Human capital is one of the fundamental aspects in organization’s effort to attain long-term survival. Consequently, firms’ human resource managers have an obligation to develop a strong workforce, which can only be achieved through effective employee recruitment, selection, and induction. The success with which an organization undertakes employee recruitment is determined by the labor market characteristics. Diversity is one of the most important aspects in nurturing an effective human capital base.

The establishment of NAFTA has greatly provided organizations with an opportunity to achieve diversity in their workplace. North America’s total population is estimated to be 471,964,016, which is approximately 25% of the total world population. NAFTA’s agreements have created an environment that has promoted labor mobility. Subsequently, organizations can easily exploit the diversity in the labor market, which enhances organizations’ success with regard to innovation, research, and development. The high level of integration with regard to human capital has provided Mexican, American, and Canadian organizations with an opportunity to collaborate in implementing diverse projects (Lederman, Maloney and Serven 111).


As one of the trading blocs in North America, NAFTA has augmented competitiveness amongst businesses in the region. The elimination of trade tariffs has provided businesses within the member states with an opportunity to operate cost-effectively. For example, the cost of exporting goods and services into the member states has been reduced significantly.

Therefore, businesses can set a competitive price for their products in a foreign market. Since its establishment, NAFTA has led to a remarkable prosperity for businesses and families within the member states. For example, NAFTA has provided consumers with an opportunity to select from a wide range of choices.

One of the issues that the trade agreement has focused on entails the member states adhering to the set rules. Since its establishment, NAFTA has ensured minimal variability in the set rules, which has improved the degree of predictability with regard to the legal environment. This environment has improved the level of specialization in businesses, hence nurturing their competitiveness.

Respecting basic labor standards

Through the NAALC, NAFTA has been successful in promoting effective working conditions amongst the member states. The member states have an obligation to adhere to the set labor rules and regulations. In its quest to promote labor standards amongst the member states, NAALC undertakes intergovernmental consultation and constant evaluations on various labor issues. These consultations enable NAFTA to formulate comprehensive action plans, hence increasing the effectiveness with which the issues that arise are addressed. Some of the labor aspects that NAFTA has taken into account in its operation include industrial relations, migrant worker issues, child labor, health and safety, and gender equity.


Despite the criticisms that have been levelled against NAFTA by activists and various lobby groups, its establishment has a remarkable impact on the overall business environment in Canada, the US, and Mexico. First, NAFTA has led to the elimination of the prevailing tariff and non-tariff barriers that adversely affected business amongst the three countries.

Subsequently, it is relatively easy for foreign investors to venture into the three countries and establish business operations through either FDI or exportation. Additionally, NAFTA has implemented a number of provisions on diverse issues such as environmental protection, dispute resolution, and labor relations. The implemented rules and regulations on environmental protection have steered businesses towards achieving environmental sustainability, which is a fundamental element in the long-term operation of businesses during the 21st century.

On the other hand, the implemented dispute resolution mechanism has led to improvement in the working relations amongst companies from the respective member states. Companies in the member states have an obligation to obey the set labor standards, failure to which they are subject to a penalty.

Therefore, businesses have an opportunity to exploit the diversity presented by the broad labor market amongst the three countries. The economic growth especially in export related sectors has increased job opportunities for citizens. Subsequently, NAFTA has greatly improved the citizens’ living standards. NAFTA has also provided businesses with an opportunity to market their products to a large number of customers, hence stimulating their profitability. Subsequently, businesses have a greater opportunity to improve their competitiveness.

Works Cited

Baier, Scott, and Jeffrey Bergstrand. “The growth of world trade: tariffs, transport costs and income similarity.” Journal of International Economics 53.1 (2001): 1-27. Print.

Chambers, Edward, and Peter Smith. NAFTA in the new millennium, San Diego: University of California, 2002. Print.

Foxley, Alejandro. Regional trade blocs; the way to the future, Washington, D.C: Carnegie Endowment for International Peace, 2010. Print.

Hufbauer, Gary, and Jeffrey Schott. NAFTA Revisited: Achievements and Challenges, Washington, D.C.: Institute for International Economics, 2005. Print.

Lederman, Daniel, Francis Maloney, Luis Serven. Lessons from NAFTA for Latin America and the Caribbean, Palo Alto: Stanford University Press, 2005. Print.

Seal, Jan. The North American Free Trade Agreement Rules of Origin and Documentation, New York: CreateSpace Independent Publishing, 2013. Print.